China premier remarks help cap Hong Kong dollar

LisaTwaronite

SAN FRANCISCO (MarketWatch) -- The Hong Kong Monetary Authority apparently got unexpected -- and perhaps not entirely welcome -- help from China's premier in its recent campaign to maintain its currency's peg to the U.S. dollar amid massive inflows of capital into the territory.

The move "did the Hong Kong dollar and local stock market no favors," wrote Marc Chandler, currency strategist at Brown Brothers Harriman. "The bottom line is that the bid that the Hang Seng caught in response to the euphoria of mainland money has been lost."

Since 1983, the HKMA has pegged the Hong Kong dollar at 7.80 against its U.S. counterpart, allowing it to trade within a narrow range between 7.75 and 7.85.

Whenever the U.S. dollar hits the bottom of the range in the spot currency market, the de facto central bank has to intervene and sell its currency to maintain the peg.

Over the past two weeks, the HKMA intervened seven times in foreign exchange markets -- its first such intervention in two years.

"Last week officials injected the equivalent of more than $1 billion into the money market and this has pushed overnight rates down to 2%, around where they are currently quoted. This has been one of the factors that have helped lift the U.S. dollar off its floor against the Hong Kong dollar," wrote Chandler.

Wen's weekend comments, though likely not intended as such, were another factor.

The Chinese leader told Hong Kong reporters Saturday during his visit to Uzbekistan that the Chinese government needed to fully consider the potential negative effects the plan could have on both mainland and Hong Kong stock markets, according to news reports.

Officials should "make a scientific judgment and analysis on what impact the massive funds flooding the Hong Kong financial market could have," Wen was quoted as saying by The Wall Street Journal.

The plan's announcement in August by China's State Administration of Foreign Exchange sent Hong Kong shares soaring about 40%, and increased the torrent of speculative cash already flowing into the territory.

In addition to the plan, high-profile initial public offerings have led to more fund inflows and created even more upward pressure on the Hong Kong dollar.

Peg to remain....for now

Most currency analysts say the HKMA's peg is here to stay for the foreseeable future, as the monetary authority has no desire to do anything to upset the status quo.

The peg was tested on the downside during the 1997-98 Asian financial crisis, when the HKMA intervened to buy its currency and raised interest rates to counter speculator pressure.

But now that the Hong Kong dollar is appreciating rather than depreciating, the question is whether the peg is advantageous to maintain -- and, if not, how to bring about systemic change without destabilizing the entire financial system.

"The whole risk system in Hong Kong is hugely geared around confidence in the peg," said James Malcolm, global emerging markets currency strategist at Deutsche Bank in London.

But keeping the peg means intervening -- and pumping even more liquidity into the already flooded banking system. It also means linking monetary policy to U.S. moves, which are aimed at a far different economy.

Last Thursday, in lock-step with the U.S. Federal Reserve's quarter percentage-point rate cut, the HKMA cut its reference rate for overnight loans to local banks to 6.0% from 6.25%.

While the status quo is likely to hold, "there are signs of some shift taking place in terms of perception within policy circles," Malcolm said.

In September, after the Fed cut rates by half a percentage point to support the U.S. economy and Hong Kong duly followed suit, one former HKMA deputy chief executive openly questioned how long the relationship ought to last.

"[Economic] conditions here demand something different from the U.S.," Tony Latter was quoted as saying in the Financial Times, adding, "It's not always nice to have your monetary policy decided from abroad."

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